IRC Section 67(e) Deductions for Estates and Trusts

Under Internal Revenue Code Section 67(e), an estate or non-grantor trust can fully deduct administrative costs on Form 1041 if those costs would not have been incurred had the property been held by an individual. These deductions come off the top in computing adjusted gross income, and they are the only remaining path to a federal deduction for most fiduciary administrative expenses. Anything that fails the test produces no federal tax benefit at all.

Why the Classification Is All or Nothing

Trusts and estates reach the 37% federal bracket at income levels an individual would consider modest. That compression means each dollar of deductible administrative expense removed from the entity’s income can save tax at the top rate.

Section 67(e) either lets the expense come off in full or leaves it stranded. There is no partial deduction and no fallback treatment. The Tax Cuts and Jobs Act suspended miscellaneous itemized deductions for tax years beginning after December 31, 2017, and the One Big Beautiful Bill Act (Pub. L. 119-21) made that suspension permanent, removing the sunset and redesignating the provision as IRC 67(h).¹² Before the TCJA, an expense that failed the 67(e) test could still be partially deducted above the 2% floor. That safety net is gone.

The IRS confirmed the current framework in Notice 2018-61: expenses described in Section 67(e) are treated as deductions in arriving at AGI and were never miscellaneous itemized deductions in the first place, so they remain fully deductible.³

The Two-Part Test

Section 67(e)(1) covers costs paid or incurred in connection with administering the estate or trust that would not have been incurred if the property were not held in the trust or estate.² Two conditions must both be satisfied. The expense has to be tied to administration, and it has to be one that an individual holding the same property would not commonly incur. A cost that is connected to administration but that any property owner would also pay fails.

Section 67(e)(2) separately preserves the deductions allowed under Sections 642(b), 651, and 661, including the entity’s personal exemption and the distribution deduction. Those are mechanical and rarely in dispute. The friction is almost always in (e)(1).

Expenses That Qualify

Treasury Regulation 1.67-4 and the Form 1041 instructions identify categories that clear the test because they exist only because the property sits inside a fiduciary entity:

Fiduciary fees paid to a trustee or executor for administering the entity.⁴
Legal fees for estate settlement, trust administration, court filings, and advice on fiduciary duties.
Preparation fees for the entity’s Form 1041, the decedent’s final individual return, and any estate or generation-skipping transfer tax returns.⁵
Judicial accounting costs.
Fiduciary bond premiums.
Probate court fees and legal publication costs.
Appraisal fees to establish value as of the date of death, the alternate valuation date, or to support distributions to beneficiaries.
Costs of distributing income or principal to beneficiaries under the governing instrument.

An individual managing a personal brokerage account does not post a fiduciary bond, submit to judicial accounting, or pay probate filing fees. Those obligations flow from the trust instrument or state fiduciary law, and the costs of meeting them survive the permanent suspension.

Expenses That Do Not Qualify

The Supreme Court drew the main boundary in Knight v. Commissioner, holding that investment advisory fees are generally subject to the (former) 2% floor because hiring an investment adviser is not uncommon or unusual for individuals.⁶ The Court’s test asks whether it would be uncommon, unusual, or unlikely for a hypothetical individual holding the same property to incur the cost. If individuals commonly pay for the same service, the expense fails.

The Court left a narrow opening. When an investment adviser charges a special fee that applies only to fiduciary accounts, or when the trust has an unusual investment objective requiring specialized balancing of competing beneficiary interests, the incremental cost beyond what an ordinary investor would pay can qualify.⁷ The baseline advisory fee is not deductible; only the incremental piece attributable to the fiduciary nature of the account can be.

Treasury Regulation 1.67-4 lists additional non-qualifying categories:

Ownership costs such as condominium fees, insurance premiums, property maintenance, lawn services, and automobile registration.⁵
Preparation of returns individuals commonly file, such as gift tax returns.
Appraisals obtained to set a selling price or to arrange insurance coverage.
General investment advisory fees at the level any individual investor would pay.

None of these produce a federal income tax benefit now. Misclassifying one as a 67(e) expense means the deduction was never available in the first place.

Splitting a Bundled Fee

Corporate trustees often charge a single percentage-based fee covering investment management, tax compliance, beneficiary communications, and administration. Treasury Regulation 1.67-4(c) requires the fiduciary to split that fee between the investment advice portion (non-qualifying) and everything else (qualifying under 67(e)). For fees not computed hourly, only the investment advice component is treated as non-qualifying; the rest remains fully deductible.⁵

The regulation does not prescribe a formula. It requires a reasonable method. Factors that support reasonableness include the percentage of the corpus subject to investment advice, what a third-party adviser would charge for comparable advisory services alone, and how the fiduciary’s time is actually spent between investment decisions and other duties. Identifiable payments to third parties, such as brokerage commissions inside the bundled fee, are separated out directly rather than folded into the allocation. Document the method and keep the workpapers. The split affects the tax bill every year the trust exists.

Where 67(e) Deductions Go on Form 1041

Qualifying deductions appear on the front page of Form 1041, reducing AGI before taxable income is computed. The instructions assign specific lines:⁴

Line 12 for fiduciary fees.
Line 14 for attorney, accountant, and return preparer fees tied to qualifying fiduciary returns (Form 1041, estate tax returns, GST returns, and the decedent’s final individual return).
Line 15a for other allowable 67(e) deductions, with an attached statement listing each item by type and amount.

Expenses that fail the test are not reported as deductions anywhere on Form 1041. There is no longer a line for miscellaneous itemized deductions subject to a floor, because no such deduction exists.

Passing Excess Deductions to Beneficiaries at Termination

In the final tax year of an estate or trust, deductions can exceed income. IRC Section 642(h) allows the excess to pass through to the beneficiaries who succeed to the property, and each deduction keeps its character in the beneficiary’s hands. A 67(e) expense that was above-the-line for the trust remains above-the-line for the beneficiary.⁸

The pass-through is reported on Schedule K-1 (Form 1041), Box 11. Code A carries Section 67(e) expenses, which the beneficiary claims as an adjustment to income on Schedule 1 (Form 1040), Part II, Line 24k. Code B carries non-miscellaneous itemized deductions, reported on the beneficiary’s Schedule A.⁹

Two limits matter. Excess deductions that would be classified as miscellaneous itemized deductions produce no benefit for the beneficiary because those deductions remain suspended. And the beneficiary cannot carry unused excess deductions forward. Whatever the beneficiary’s income in the termination year cannot absorb is lost. Fiduciaries closing a trust should time the termination with the beneficiary’s income year in mind, so that deductions built up over years of administration are not wasted in the last one.

1
Congress.gov. Tax Provisions in H.R. 1, the One Big Beautiful Bill Act
2
Office of the Law Revision Counsel. 26 USC 67 – 2-Percent Floor on Miscellaneous Itemized Deductions
3
Internal Revenue Service. Notice 2018-61
4
Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1
5
eCFR. 26 CFR 1.67-4 – Costs Paid or Incurred by Estates or Non-Grantor Trusts
6
Justia Law. Knight v Commissioner, 552 US 181 (2008)
7
Cornell Law School / Legal Information Institute (LII). Knight v Commissioner of Internal Revenue
8
eCFR. 26 CFR 1.642(h)-2 – Excess Deductions on Termination of an Estate or Trust
9
Internal Revenue Service. Instructions for Schedule K-1 (Form 1041) for a Beneficiary Filing Form 1040 or 1040-SR